In the face of commoditization and fierce competition, financial markets firms have continued to thrive by innovating and hustling, leading to an overall 15 percent return on equity (ROE) over the last decade, compared to 8.7 percent ROE for the average company. Firms have long benefited from the edge provided by proprietary information access and market insight, but these advantages will come under significant pressure over the next decade as two inexorable trends accelerate: transparency and speed. As these two forces approach their limits – transparency can't exceed the point at which everyone knows everything, and speed can't move beyond the instantaneous – many of today’s profit engines will stall, while new value engines will begin firing on all cylinders. Firms must be able to succeed in an environment where analysis, not knowledge, is the value creator, and where it's not seconds that count, but milliseconds. Power will shift from the traders who have benefited from merely facilitating transactions to the buyers and sellers who take positions on either end of the trade, and that which is most highly prized in financial markets – the ability to create value – is likely to experience a renaissance as transformational as anything the industry has ever witnessed. To gain a clearer understanding of the future of the industry, the IBM Institute for Business Value, in cooperation with the Economist Intelligence Unit (EIU), conducted a global survey of more than 400 financial markets executives representing the buy side, the sell side and processors, as well as academics, plan sponsors, industry associations and regulatory bodies. The interviews and survey spanned 61 countries in the Americas, Asia and Europe. Nearly three-quarters of those surveyed believe that the industry will be significantly different in 2015, yet 46 percent rate themselves as only moderately able to respond to change. The fundamental task for firms will be to develop a clear perspective on risk. Value will be created in two ways: by effectively assuming and managing risk, or by mitigating risk, either by taking it out of the overall system, or by reducing it for their clients. Today, we characterize industry segments in terms of buy side, sell side and processors out of convenience. However, as value bifurcates on the risk dimension, this terminology may eventually become irrelevant. Driven by transparency and speed, the industry will change substantially in the coming years. Excess agency profits will evaporate, the separation of alpha and beta will become complete, and the creation of alliances will be critical. In addition, demanding institutional and retail clients will drive a shift from a transaction perspective to one that is truly centered on the client. We recommend four basic steps to begin preparing for the future: - Determine your optimal long-term relationship with risk
- Partner selectively to fully exploit your strategic, differentiating capabilities
- Optimize the profitability of each client
- Develop a purposeful, systematic culture of innovation.
And, once you've decided on the strategic direction for each of these four steps, then, of course, you must execute. New value engines – Risk assumption and risk mitigation
As 2015 approaches, where will the new sources of profitability and revenue growth emerge? Thanks to the wide-ranging effects of transparency and speed, profit opportunity will bifurcate on a risk dimension, into risk assumption and risk mitigation activities. On one hand, there will be value in activities that require the assumption of risk (alternative asset management and performance sharing, for example). On the other hand will be activities that reduce risk on behalf of others (such as those performed by custodians, vendor processing utilities or advice givers). To better understand probable sources of growing and declining value over the next ten years, the IBM Institute for Business Value developed a financial model to gauge the likely profitability and revenue outlook for a range of industry activities (see Figure 1). The analysis focused on activities that are expected to have a high degree of positive or negative growth over the next ten years. 
Ultimately, firms need to reexamine their relationships with risk to uncover new ways to grow in the industry's renaissance. Transparency and speed are driving firms to develop a true client orientation and optimize risk/return efficiency, and are pushing them to become specialist enterprises – a task that will require a conscientious approach to innovation and significant modification of their operating models. By assessing its own particular strengths and long-term strategic goals, each firm can then articulate and execute its most profitable future relationship with risk. To read the full study, download the PDF file at the top of this page. |
